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P/E: How much investors will pay for $1 of earnings. High is good.

M/B: How much paid for $1 of book value. Higher is good.

P/E and M/B are high if ROE is high, risk is low.

2005E 2004 2003 Ind.P/E 12.0x -6.3x 9.7x 14.2xP/CF 8.2x 27.5x 8.0x 7.6xM/B 1.5x 1.1x 1.3x 2.9x

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Common Size Balance Sheets:Divide all items by Total Assets

Assets 2003 2004 2005E Ind.Cash 0.6% 0.3% 0.4% 0.3%ST Invest. 3.3% 0.7% 2.0% 0.3%AR 23.9% 21.9% 25.0% 22.4%Invent. 48.7% 44.6% 48.8% 41.2%Total CA 76.5% 67.4% 76.2% 64.1%Net FA 23.5% 32.6% 23.8% 35.9%TA 100.0% 100.0% 100.0% 100.0%

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Divide all items by Total Liabilities & Equity

2003 2004 2005E Ind.AP 9.9% 11.2% 10.2% 11.9%Notes pay. 13.6% 24.9% 8.5% 2.4%Accruals 9.3% 9.9% 10.8% 9.5%Total CL 32.8% 46.0% 29.6% 23.7%LT Debt 22.0% 34.6% 14.2% 26.3%Total eq. 45.2% 19.3% 56.2% 50.0%Total L&E 100.0% 100.0% 100.0% 100.0%

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Analysis of Common Size Balance Sheets

Computron has higher proportion of inventory and current assets than Industry.

Computron now has more equity (which means LESS debt) than Industry.

Computron has more short-term debt than industry, but less long-term debt than industry.

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Common Size Income Statement:Divide all items by Sales

2003 2004 2005E Ind.Sales 100.0% 100.0% 100.0% 100.0%COGS 83.4% 85.4% 82.4% 84.5%Other exp. 9.9% 12.3% 8.7% 4.4%Depr. 0.6% 2.0% 1.7% 4.0% EBIT 6.1% 0.3% 7.1% 7.1%Int. Exp. 1.8% 3.0% 1.1% 1.1% EBT 4.3% -2.7% 6.0% 5.9%Taxes 1.7% -1.1% 2.4% 2.4%NI 2.6% -1.6% 3.6% 3.6%

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Analysis of Common Size Income Statements

Computron has lower COGS (86.7) than industry (84.5), but higher other expenses. Result is that Computron has similar EBIT (7.1) as industry.

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Percentage Change Analysis: Find Percentage Change from First Year (2003)

Income St. 2003 2004 2005ESales 0.0% 70.0% 105.0%COGS 0.0% 73.9% 102.5%Other exp. 0.0% 111.8% 80.3%Depr. 0.0% 518.8% 534.9% EBIT 0.0% -91.7% 140.4%Int. Exp. 0.0% 181.6% 28.0% EBT 0.0% -208.2% 188.3%Taxes 0.0% -208.2% 188.3%NI 0.0% -208.2% 188.3%

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Analysis of Percent Change Income Statement

We see that 2005 sales grew 105% from 2003, and that NI grew 188% from 2003.

So Computron has become more profitable.

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Percentage Change Balance Sheets

Assets 2003 2004 2005ECash 0.0% -19.1% 55.6%ST Invest. 0.0% -58.8% 47.4%AR 0.0% 80.0% 150.0%Invent. 0.0% 80.0% 140.0%Total CA 0.0% 73.2% 138.4%Net FA 0.0% 172.6% 142.7%TA 0.0% 96.5% 139.4%

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Liab. & Eq. 2003 2004 2005EAP 0.0% 122.5% 147.1%Notes pay. 0.0% 260.0% 50.0%Accruals 0.0% 109.5% 179.4%Total CL 0.0% 175.9% 115.9%LT Debt 0.0% 209.2% 54.6%Total eq. 0.0% -16.0% 197.9%Total L&E 0.0% 96.5% 139.4%

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Analysis of Percent Change Balance Sheets

We see that total assets grew at a rate of 139%, while sales grew at a rate of only 105%. So asset utilization remains a problem.

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Explain the Du Pont System

The Du Pont system focuses on:

Expense control (PM)

Asset utilization (TATO)

Debt utilization (EM)

It shows how these factors combine to determine the ROE.

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( )( )( ) = ROE

Profitmargin

TAturnover

Equitymultiplier

NI Sales

SalesTA

TA CE

2003 2.6% x 2.3 x 2.2 = 13.2%2004 -1.6% x 2.0 x 5.2 = -16.6%2005 3.6% x 2.0 x 1.8 = 13.0%Ind. 3.6% x 2.5 x 2.0 = 18.0%

The Du Pont System

x x = ROE.

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What are some potential problems and limitations of financial ratio analysis?

Comparison with industry averages is difficult if the firm operates many different divisions.

“Average” performance is not necessarily good.

Seasonal factors can distort ratios.

(More…)

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Window dressing techniques can make statements and ratios look better.

Different accounting and operating practices can distort comparisons.

Sometimes it is difficult to tell if a ratio value is “good” or “bad.”

Often, different ratios give different signals, so it is difficult to tell, on balance, whether a company is in a strong or weak financial condition.

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What are some qualitative factors analysts should consider when

evaluating a company’s likely future financial performance?

Are the company’s revenues tied to a single customer?

To what extent are the company’s revenues tied to a single product?

To what extent does the company rely on a single supplier? (More…)

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What percentage of the company’s business is generated overseas?

What is the competitive situation?

What does the future have in store?

What is the company’s legal and regulatory environment?